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What is a Reverse Mortgage? Pros and Cons of this complex loan

If you are looking for ways to improve your cash flow or free up some of the equity in your home, you might have heard of reverse mortgages. Today at The Senior List we’re going to take an impartial look at reverse mortgages: What they are, how they work, who might benefit, the pros and cons, and any risks you need to be aware of.

What Is A Reverse Mortgage?

A reverse mortgage is a home equity loan taken out against your house. You receive a monthly payment from the loan. The loan must be paid back if you move out, or in the event of your death.  Reverse mortgages are available for people aged 62 or over.

How Does A Reverse Mortgage Work?

Unlike traditional mortgages, where you pay the lender each month, a reverse mortgage means the lender pays you. How does that work? Well, the reverse mortgage is considered an advance against the equity of your home. Of course that also means you have to repay it one day.

Related: 5 Reasons NOT to Have Estate Plans

Should you move out or sell your home, you must pay back the loan. In the event of your death, your estate or surviving spouse becomes liable, depending on the exact terms of the mortgage. In all events, the loan is usually resolved by selling the house to free up the money to pay it back.

A reverse mortgage can help older adults remain at home, but at what cost?
A reverse mortgage can help older adults remain at home, but at what cost? © Can Stock Photo / lmphot

There are three types of reverse mortgage:

Single-purpose reverse mortgages are taken out for a single agreed-upon purpose, such as home repairs. They are available from state and local government agencies, as well as from some non-profits.

Proprietary reverse mortgages are private loans that are backed by the company you borrow from. They can be used for any purpose.

Home equity conversion mortgages (also known as HECMs) are federally-insured reverse mortgages, which can be used for any purpose.

Who Might Benefit From A Reverse Mortgage?

Reverse mortgages are best suited to people who don’t plan to move. If you plan to move, a reverse mortgage could tie up a lot of your home value in repaying the loan, and make it difficult to afford to move elsewhere.

However, if you are planning to stay in your home, a reverse mortgage can give you access to money to supplement your income, pay expenses, or put aside for a rainy day.

Taxes, Insurance and Home Maintenance

Reverse mortgages are best suited to borrowers who have the funds and health necessary to keep up the maintenance of their home. Under the terms of a reverse mortgage, the home must be kept in more or less the same state, with no dramatic deterioration. Reasonable wear and tear is acceptable, but do be sure you are able to keep up repairs and maintenance, or pay to have them done.

Borrowers must also stay up to date with all tax and insurance payments on their home.

Related: Planning for Retirement? Don't Make These Mistakes

Pros and Cons to a Reverse Mortgage

The main pros and cons of reverse mortgages include …

Pros:

  • There are no monthly payments to be made
  • You receive regular monthly payments
  • Regular payments can help with budgeting and cashflow
  • Can be used to pay off your existing mortgage, thus cutting your monthly outgoings
  • Payments are usually tax free

Cons:

  • You are responsible for maintaining the house and paying all taxes and insurances on it
  • The fees and associated costs can be high
  • Has a direct impact on whether the house can stay in the family, as upon death it may need to be sold to pay off the loan
  • The payments might push you over the limit for claiming Medicaid

Risks To Be Aware Of

We would caution readers to be aware that a reverse mortgage ties up your home equity, and can make it difficult to sell your home, or leave it to your loved ones in the event of your death.

Reverse mortgages can be complex, and it is important not to rush into the decision to take one.

In particular, some reverse mortgages include stipulations about circumstances that can trigger foreclosure of your home, or a request for repayment of the loan. For example, some lenders require repayment if your home is unoccupied for a certain amount of time, which could be a problem if you require an extended hospital stay.

Always Get Advice

Our advice to our readers who are considering a reverse mortgage is to always get advice. Remember that lenders want you to say yes, so their pitches might be quite aggressive, or not adequately address the risks.

Always get unbiased advice before taking out a reverse mortgage. You might like to contact a fee-only financial planner. Because they are fee-only they have no vested interest in whether you take out the loan or not. Some people also opt to have a lawyer look over the contract.

Reverse mortgage are a viable option for some people, but are not suited to every senior homeowner. Whatever you decide, always be sure you fully understand the terms, fees, risks and costs before signing up for a reverse mortgage.

Comments

  1. Reverse mortgages (and FHA-backed Home Equity Conversion Mortgages) can be quite complex and confusing, and potential borrowers need to consider not only the structure of the reverse mortgage (lump-sum loan, line of credit, tenure payment) but also consider a range of possible long-term outcomes, including running out of equity to borrow. These are reasons that FHA requires that potential borrowers meet with a HUD-approved financial counselor. It may be that a reverse mortgage or HECM will provide a solid financial opportunity for a homeowner, but recent changes to the HECM program increases up-front mandatory insurance premium costs in exchange for lower long-term ones while also imposing tighter restrictions on the amount of money a senior can access. The combination of these factors may limit the usefulness of an HECM for at least some senior homeowners.

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